The prices of the metals moved mostly sideways this week. That is, until
Friday. Then foom! (Foom is the sound of a rocket taking
off.)
From 6 to 10am (Arizona time, i.e. 8 to 12 NY time) the price of gold rose
from $1,061 to $1,087. Not surprisingly, the silver price rose a greater
percentage, from $14.14 to $14.59.
The catalyst seems to be the Bureau of Labor Statics jobs report. There were
a few more jobs created than expected, which means the economy is doing well
and/or the Fed is more likely to raise interest rates this month (the Fed has
said it is basing its decision on labor market conditions, among other
indicators). Whatever it was, it lit the fuse and sent the silver price up 45
cents. It held this level, and this represents the entire silver price gain
for the week.
Many readers have asked us what we think of technical analysis. Our
challenge with it, is the attempt to predict future price changes from past
price changes. This is especially so in the gold and silver markets, as there
are such large stocks relative to flows. In gold, by official estimates, the
stocks to flows is around 70 years. Compare this to ordinary commodities,
where this ratio is more like 0.25 years.
Why do we mention stocks to flows in this context? The speculators are
trying to move something of much greater inertia. While one could conceivably
corner the market in rareearthium, it’s impossible with gold or
silver. Just ask Herbert and Bunker Hunt, or Warren Buffet.
The movement of stocks in and out of carry tells us about the speculators,
because we can watch their impact on the basis. Speculators can push the
price around—temporarily. But they can’t move it durably, because the
hoarders are accumulating or decumulating much larger quantities. To use an
analogy to flowing water, one could easily divert the water on one’s
driveway, but not a major river.
We will look at how Friday’s price jump affected the silver term
structure. But first, here’s the graph of the metals’ prices.
The Prices of Gold and Silver
We are interested in the changing equilibrium created when some market
participants are accumulating hoards and others are dishoarding. Of course,
what makes it exciting is that speculators can (temporarily) exaggerate or
fight against the trend. The speculators are often acting on rumors,
technical analysis, or partial data about flows into or out of one corner of the
market. That kind of information can’t tell them whether the globe, on net,
is hoarding or dishoarding.
One could point out that gold does not, on net, go into or out of
anything. Yes, that is true. But it can come out of hoards and into carry
trades. That is what we study. The gold basis tells us about this dynamic.
Conventional techniques for analyzing supply and demand are
inapplicable to gold and silver, because the monetary metals have such high
inventories. In normal commodities, inventories divided by annual production
(stocks to flows) can be measured in months. The world just does not keep
much inventory in wheat or oil.
With gold and silver, stocks to flows is measured in decades. Every
ounce of those massive stockpiles is potential supply. Everyone on the planet
is potential demand. At the right price, and under the right conditions.
Looking at incremental changes in mine output or electronic manufacturing is
not helpful to predict the future prices of the metals. For an introduction
and guide to our concepts and theory, click here.
Next, this is a graph of the gold price measured in silver, otherwise
known as the gold to silver ratio. The ratio fell slightly this week.
The Ratio of the Gold Price to the Silver Price
For each metal, we will look at a graph of the basis and cobasis
overlaid with the price of the dollar in terms of the respective metal. It
will make it easier to provide brief commentary. The dollar will be
represented in green, the basis in blue and cobasis in red.
Here is the gold graph.
The Gold Basis and Cobasis and the Dollar Price
The price of the dollar (i.e. the inverse of the price of gold, measured
in dollars) continued its neat correlation with the cobasis (i.e. scarcity of
gold). In other words, as the price of gold rises, it becomes less scarce on
the market. As it falls, it becomes scarcer. This has been the market mode
for quite a while now.
Friday’s price action did not break the pattern.
Unfortunately, for gold bulls, with every tick up in price the decrease in
scarcity is larger, and with every tick down in price, the increase in
scarcity is smaller. In other words, our calculated fundamental price
continues its slow slide which began the second week of September. That said,
the fundamental price is still more than $100 over the market, just under
$1200.
Now let’s look at silver.
The Silver Basis and Cobasis and the Dollar Price
The same pattern also occurs in silver, and more. Last week, the March
silver cobasis was near the same level as the February gold cobasis. Now it
has fallen quite a bit more.
The fundamental price of silver also came down a bit, now a scant quarter
above the market price.
Finally, let’s take a look at what happened to the silver basis as the
price rocketed up.
Three Snapshots of the Silver Term Structure
Think of the term structure of the basis like a yield curve for the bond
market. The basis is the profit you can earn to carry silver, quoted as an
annualized percentage. Since one can borrow dollars (often at LIBOR) to carry
silver, the basis tends to be pretty close to LIBOR.
That said, we are interested in change at the margin.
This graph shows three snapshots. One was taken before the price began
spiking, one was in the middle of it, and one was after. It is interesting to
see that the greatest effect on basis occurred in the January contract, with
the least on the December 2016 contract.
The graph clearly shows a dramatic increase in the basis, especially in
the near contracts. Why is this significant?
Recall that basis is (to oversimplify—for a full explanation, click here)
the future price – spot price. There was a frenzy of buying that pushed up
the silver price more than 3% in a few hours. That frenzy was not stackers
lining up to buy phyz. It was speculators buying paper.
Why does that matter? Speculators, who typically use leverage, can’t hold
the market price against the tide of the hoarders. They can push for a while,
but they have to close their positions sooner or later, either to take
profits (as they reckon them, in dollars) or to stop losses.
There will come a day when the prices of the metals are rising due to
insatiable demand for metal. As Aragorn would say, “Friday was not that day!”
© 2015 Monetary
Metals
